Valuation and

financial reporting
for properties
under development
Real Estate, Hospitality
and Construction
Development Roundtable
2017
Dear real estate professional
With the significant growth of development activity across the
Greater Toronto Area and, to some extent, other markets across
Canada, real estate developers, owners, their boards and their
investors are increasingly focused on the way they approach the
valuation of their development property portfolios.

In September 2017, EY facilitated a roundtable discussion hosting

a group of approximately 50 senior finance and development
executives from a broad range of real estate-focused entities.
The session gave attendees the opportunity to share and gather
insight on the various valuation methods and polices adopted in the
development sector.

All participants’ names have been kept confidential, and their

responses were only used in combination with others to protect
anonymity.

EY would like to thank those who attended the Development

Forum Roundtable.

If you have questions about the Development Forum Roundtable,

please reach out to your EY representative or any of the contacts
listed at the end of this report.

Zach Pendley Stephanie Lamont

Partner, Partner,
Transaction Advisory Services Assurance Services
Real Estate, Hospitality Real Estate, Hospitality
and Construction and Construction
Toronto, ON Toronto, ON
With rapid changes in the
market, it is increasingly
challenging to use cost as
a proxy for fair value.

Valuation and financial reporting for properties under development 1

Fair value adoption framework
Properties under development

The Greater Toronto Area is no stranger to the development

market. The City of Toronto reported 27 residential land
transactions in Q2 2017 and Urban Toronto issued a report
in spring 2017 identifying approximately 840 development More than half of the
projects in the GTA. With historically low vacancy rates in
both the commercial and residential real estate spaces, land attendees acknowledged
values continue to appreciate.
having a formal guideline
With growing demand and supply constraints on both
development land and institutional or investment grade (varying degrees of
assets, real estate owners and developers are now re-
evaluating the highest and best use to extract value. This
flexibility) when
potentially leads to the redevelopment of various assets. determining when to
The approach to valuation is typically unanimous across transition from cost
the sector during the property (land) held for development
(PHFD) and income-producing property (IPP) stages. approximating fair value
However, the fair value of properties under development
(PUD) can be more difficult to value. As such, fair value to a cash flow or yield
measurement of PUD is an area receiving particular focus
from issuers and auditors.
method of determining
Sources: Altus InSite Investment Trends Survey, Realnet, MCAP, UrbanToronto, CBRE. fair value.

840
DEVELOPMENT
projects in GTA
Source: UrbanToronto (April 2017)

2 Valuation and financial reporting for properties under development

At what stage do you move away from
cost approximating fair value?

Earlier adoption may occur if the developer

is under a fixed cost contract with the
contractor and if the asset is substantially
pre-leased

Pre-leasing status 50% 75%

Construction status 50% 90%

Late adopters. Some attendees expressed the view that

the switch to a yield/cash flow method should be closer
to when the property is fully operational. As a result,
these sometimes resulted in significantly large fair value
bumps upon transfer.

Some groups have guidelines in place Disclosures surrounding asset type,

that assess either percent of gross or development status, various phases and

A majority of net leased area or percent of revenue to

measure pre-leasing status, especially
staging are considered important and
helpful for users. For example, office
respondents on retail properties. towers with longer-term pre-signed
leases would have more certainty
indicated that they Generally, rather than following strict
than multi-family assets, thus earlier
policies, attendees suggested more
would typically flexible guidelines are common in
adoption may be warranted. Predictable
future revenue in the form of pre-
move from cost practice, and the time of transfer varied
based on the type of asset and the
leasing activities is a key indicator
for commercial properties. Another
to a yield or cash market. For example, in a single-tenant
consideration is the unit of measure
building with leasing in place before
flow method of construction commenced, some would
for multi-phase, multi-type large-scale
developments. It may be difficult to
valuation upon likely not wait until 50% construction is
completed to switch to a yield approach
bifurcate the value of a project by

pre-leasing and as a market participant would attribute

building, phase or asset type. Although
challenging, leading practice would
construction value to the tenant.
suggest to value these multi-phase
projects at a bifurcated level, with a
completion value assigned to each phase. The types
over 50%. of projects are common in pension
funds, and generally the in-progress
phase is valued using the income
approach, with upcoming phases valued
using cost approximating fair value.

Valuation and financial reporting for properties under development 3

 Challenges in the
measurement of the fair
value of properties under Combatting challenges
development means this
is an area on which issuers When repurposing an asset, what are some
of the challenges faced in valuation and
are particularly focused.
how are they addressed?
• One of the biggest challenges is finding the neutral or
gradual fair value increase through development — avoiding
the “hockey stick” effect on completion that may not
accurately reflect value for investors and stakeholders.
• Some attendees considered this to be an expected pattern
in development, as the risk often dissipates fastest towards
completion of the development.
• Some attendees said the accurate assessment of fair value
on the date of transfer is challenging. The decision to
repurpose the asset indicates a potentially conflicting view
of the highest and best use — its existing use is presumably
viewed as containing a flaw (hence the decision to
repurpose). There is presumably an assumption the current
value would be expected to erode over time, whether
through lower occupancy or capital requirements.
• Some attendees acknowledged incorporating development
yields/risk into a fair value assessment would be an area of
specific judgment and subjectivity.

4 Valuation and financial reporting for properties under development

Commission 3rd party Dedicated development
valuation during PUD stage valuation expert (internal)

A small group of participants would seek third party/external valuations.

The majority indicated growing interest in having a dedicated internal development valuation expert.

The degree of collaboration and the

knowledge sharing process between
development/investment teams and While timing of the adoption
the finance teams is an important
consideration in determining a reliable fair of a yield method may
value estimate (whether using cost as a
proxy or a yield method). differ for each asset type
The uniqueness of each development and market, industry
project adds challenges to finding participants will generally
comparable indicators of value and
risk assessment. refer to leasing (intent vs.
executed leases), passage
of time, and construction
progress and completion to
guide decision-making.

Valuation and financial reporting for properties under development 5

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About EY
Contacts
EY is a global leader in assurance, tax, transaction and advisory services.
The insights and quality services we deliver help build trust and confidence Zach Pendley
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© 2017 Ernst & Young LLP. All Rights Reserved.
Stephanie Lamont
A member firm of Ernst & Young Global Limited. Partner, Assurance Services
2485241 Real Estate, Hospitality and Construction
ED 00
Toronto
This publication contains information in summary form, current as of the date of publication, and is
intended for general guidance only. It should not be regarded as comprehensive or a substitute for +1 416 943 5321
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ey.com/ca Tim Buss

Senior Manager, Assurance Services
Real Estate, Hospitality and Construction
Toronto
+1 416 932 5936
tim.buss@ca.ey.com